The successful (although delayed) IPO of Argent Energy Trust this August, which raised $212-million, marked what just may be the return of the much-missed income trust — albeit with a twist.

Argent is the third of a new wave of income trusts now known as cross-border income trusts (CBITs) to hit the Canadian capital markets, effectively filling the dead space left when their predecessors were shut down four years ago.

David F. Phillips, corporate finance partner at Bennett Jones LLP in Calgary, worked on the launch of all three of the newish income trusts. “Argent’s closing was further proof of concept in a difficult market,” he says. “Assuming a few more come along, they will gain even more market exposure and interest, and could start a bit of a snowball.”

First out of the gate was Eagle Energy Trust in 2010, followed by Parallel Energy Trust in 2011 and now Argent — and all hold oil and gas assets, which is how the first wave of income trusts got their start.

The difference Whereas the first wave of income trusts held Canadian assets, crossborder income trusts can only hold foreign assets. This elegant tweak should save this new breed from the same fate as its predecessors by keeping them off the finance minister’s radar.

“Structurally, these new trusts are the same as the old trusts,” says John Osler, a partner in McCarthy Tétrault LLP’s business law group in Calgary. “The wrinkle is if the trusts do not hold Canadian assets but instead generate their revenue from assets outside of Canada, they are not subject to the tax.” A little history The first generation of income trusts appeared in the 1990s and quickly picked up speed for a very specific reason: They delivered yield tax-free to investors. In fact, by October 2006, the market cap of oil and gas income trusts alone was more than $60-billion. Once all Canadian income trusts were taken into account, including real estate income trusts (REITs), that number skyrocketed to more than $200-billion.

“The tax burden of these vehicles was born by the investor rather than the company and they were especially advantageous to investors who held their investments in RRSPs or other tax-shielded accounts,” says Mr. Phillips. “They were wildly popular.”

Too popular, as it turns out. At their height, even mattress companies and pizza franchises were held in income trusts. The tipping point hit when rumours started making the rounds that telecoms and banks might be held in income trusts. That’s when the federal government decided it could not risk losing out on any more tax revenue and on Oct. 31, 2006, Finance Minister Jim Flaherty moved to shut them down by announcing it would start taxing these structures. As a result by the end of 2011, income trusts — except for REITs, which were spared — had largely disappeared.

Then came Eagle Energy Trust, and with it, the start of a brand new era.

“I think what’s happened is management teams in Canada that have some experience in the trust sector are going into the United States and acquiring U.S. assets, selling them to a Canadian trust structure and then distributing income to holders on a flow-through basis, as the old trusts used to,” says Mr. Osler. “Certainly it’s a great time to scoop up U.S. companies at a bargain, as valuations have dropped since pre-recession highs. I know of other management groups that are kicking tires.”

The question now is whether the structure can be replicated using other asset classes and in other jurisdictions.

“It’s important to note there has been a lot of technical, legal and accounting work done to support the use of this structure. Nothing has been done to expand the asset class and jurisdiction,” says Ross Bentley, a partner with Blake, Cassels & Graydon LLP in Calgary. “That will be the new game-changer: the ability to expand beyond oil and gas and Canada and the U.S., at which point we can see tremendous opportunity to apply the structure, given the ongoing demand from investors.”

There are a few key challenges. “In the oil and gas sector, a lot of deductions are available because these are resource properties which create tax shelters in and of themselves,” says Robert Kopstein, a partner with Blakes in Calgary. “The second issue is that the U.S. anti-inversion rule makes it challenging in other asset classes for sellers who do not undertake a 100% selldown of the asset and instead choose to maintain some level of ownership. This rule effectively deems the Canadian trust a U.S. corporation and so it would take away the benefit of the structure.”

On the plus side The speed of the Canadian IPO process relative to the U.S. registration process. “We can do an IPO in three to four months, as opposed to at least six months to do a registered offering in the U.S.,” says Mr. Bentley. For U.S. companies looking to monetize their assets, this speed to market, particularly at a time of market uncertainty, is attractive.

Ironically, market uncertainty is perhaps the greatest challenge for cross-border income trusts – even in the oil and gas sector. In essence the trust has nothing. It’s just a shell when it’s created. It identifies some assets, then it has to do two things at the same time: raise the public-offering proceeds and use that money, plus some bank debt, to buy the suite of assets from a third party in the U.S. The IPO window has to be there at the same time the assets are available.

When Eagle Energy launched its IPO in 2010, it raised $169-million in a tough IPO market. Parallel followed in 2011 during a rare window of healthy IPO conditions and raised $393-million. Argent filed a prospectus in August 2011, just in time for Europe to fall apart and the raising of the debt ceiling in the U.S. It was shelved and came back to life in May 2012, but with a different suite of assets because the oil and gas properties Argent had intended to buy in 2011 were no longer available. It also scaled back its offering from $300-million and closed at $212-million.

“The joke we have is Argent had a gestation period as long as an elephant,” says Mr. Phillips. “This is not a comment on the quality of the product or the management team. The product is good. The management team is great. The assets are good. The piece that wasn’t so good was the ability to float an IPO. These are tough markets. I think when we return to healthier IPO markets, there is a lot of scope for expansion and further offerings of this type.”

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